To Survive Hard Times, Beware of The Optimism Trap

It was extraordinary. During early 2000 I'd walk into my clients' offices and find TV sets tuned to CNBC's Market Watch. However much money their businesses were making from widgets, the clients were fixated on the stock market. They were hitting it big, of course. Now the stock fortunes are gone, as are the TV sets. The CEOs whom I advise are keenly focused on their businesses once again as they confront a deteriorating economy.

I can't say that I saw the trouble coming with all the clarity of hindsight. But by September 2000 I had turned cautious. By then my firm's clients were reporting declining sales. At first the downturn was just a small dip. Our clients' companies, which are based mostly on the East Coast, are generally doing less than $25 million in sales in a wide variety of industries. I asked them to explain why their sales were dropping. Simply a temporary reaction to the crazy Nasdaq slide, they said. Once Wall Street bounced back, they reckoned, so would business.

That view prevailed into the New Year, despite a flurry of worrisome news. Christmas sales were disappointing. Some stock-market indexes were down as much as 50% from their levels just nine months earlier. The overall economic statistics were still strong, but the leading indicators were dipping. Even so, the numbers didn't unsettle our clients, who were setting their sales forecasts for 2001 at 20% over 2000's figures and budgeting accordingly.

"Here's the problem, folks," I said. "We don't know if it's a small downturn. No one has ever explained why recessions come and go. No one knows where we are headed. But after 10 years of economic expansion, it's only prudent to respond to the signs of a weakening economy. To assume the downturn is only temporary is a pretty big bet. As a CEO, you can't take the chance." The clients didn't buy it. They stuck to their rosy outlook.

Why the unshakable optimism?

No doubt it had a lot to do, ironically, with the confidence resulting from the extraordinary run of good times that small-business people had enjoyed for a decade. The old-line manufacturers among them had never seen a winning streak of such longevity. Profits had been good, and there was plenty of business to go around. High-tech companies, most of them born after 1991, had never known anything but good times. Downturn was scarcely in anyone's vocabulary.

Even in bad times, most entrepreneurs are optimists by nature. To start a business, you have to believe in yourself and the power of your ideas. The same optimism that compels you to start fresh is the force that sustains you, especially when money is short.

Moreover, our clients believed in Greenspan and his power to save the day. During Greenspan's 13-year reign as Federal Reserve chairman, hadn't the stock market righted itself every time it had gone into a tailspin? The resilience that Wall Street had displayed in 1997 and again in 1998, recouping steep losses in a few months and roaring ahead again, had made a particular impression. Once again, in January of this year, the Federal Reserve was cutting interest rates. Surely, the patron saint of the U.S. economy would make it all better.

As my clients saw it, the economic signals that had alarmed me were open to less dire interpretations. The statistics might merely reflect a temporary overhang from the November election flap. The slow Christmas season owed much to the snowy winter. The economy was really all right.

It wasn't until stocks collapsed in March of this year that the mood changed abruptly. Even the full-bore optimists were shaken. Although Greenspan was still slashing interest rates, he seemingly had lost the magic touch. By then, too, the banking industry was not renewing credit lines, the lifeblood of small-company growth. The CEOs whom we were counseling were no longer denying that the economy had turned against them. The likelihood of real pain was indisputable. Yet some of the CEOs still couldn't bring themselves to act decisively.

Sure, they were willing to cut a few frivolous items, such as corporate cars and stays in upscale hotels. But they couldn't face the hard choices: laying people off, reducing wages, and renegotiating debt. Instead, they started "slow paying" their vendors. Unfortunately, our clients were already being "slow paid" by their customers. Nobody was getting ahead. When the banks started squeezing, the game was over. Many companies were already barely making payroll.

Sadly, there isn't an easy out from the predicament. Once you've made all the obvious cuts, what's next? What's crucial in a downturn is to make bold decisions and take action. If you're too early and the economy bounces back quickly, you may have missed some upside potential, but you'll still be alive. Move too slowly in responding to the downturn and you may not get a second chance.

In devising a strategy, concentrate on one goal: raising cash. Start by paring surplus inventory and having a "yard sale" to unload any obsolete equipment you may have on hand. Then sit down with your banker, who is a partner in your business. Educate him or her about your circumstances. Your bank might help with delayed or even reduced loan repayments.

Finally, take the scarce cash you have and increase your marketing. The mistake most companies make is cutting marketing and sales; now is when you need sales. Make a deal with your key marketing employees to give them stock in exchange for a cut in their salaries. Get everyone out selling.

If you act decisively, you'll be likely to survive the downturn with a larger market share and a stronger company. Endurance, after all, is the hallmark of an entrepreneur.

Brad Mead is president of Delta Capital Group LLC, an investment-banking firm based in Avon, Conn., that specializes in advising and financing small companies. This column was coauthored by senior editor Joseph Rosenbloom.